JP Conklin 704-887-9880 office jp.conklin@pensfordfinancial.com www.pensfordfinancial.

com Leveling the Playing Field September 26, 2011 _______________________________________________________________________ Who would have thought the Fed would have enacted another round of quantitative easing before Penn State would have thrown a TD pass? Ok, everyone can put their hands down funny guys. Whats the over under on the number of high fives given at the PETA offices when Vick broke his hand? And congrats to the Giants for remembering it was tackle football, a concept lost on the Eagles. Hey, at least the Phillies broke their 7 game losing streak, right? Stocks had their worst week since October 2008. Italy and its banks were downgraded by S&P. Thankfully banks are doing great. Moodys downgraded BAC, WFC, and C. BACs stock is down nearly 50% this year. But of course, the Feds Operation Twist was the headline act. Operation Twist So the Fed, in its unending pursuit to avoid appearances of inaction, announced the worst kept secret since Miami footballs NCAA violations. The Fed will actively sell $400B of Treasurys with maturities between 1-3 years, forcing front end yields higher. Simultaneously, it will actively buy long end Treasurys, with an emphasis on 30 year Treasurys. Here are projections from Bridgewater on what the Fed will sell and buy as part of Operation Twist. Actively Selling Front End Treasurys
Maturity Fed Holds 0-1 years $138B 1-2 years $156B 2-3 years $221B Total $515B Will Sell $138B $156B $106B $400B

Actively Buying Long End Treasurys

Maturity Eligible Total Eligible Outstanding Eligible New Issue 6-7 years $353B $179B $174B 7-10 years $581B $383B $198B 10-30 years $521B $395B $126B Total $1.455T $957B $498B Will Buy $140B $160B $100B $400B

On a relative basis, Operation Twist will actually exceed QE2 (but without the pesky political falloutyet) because of duration. QE2 focused on 3-7 years while Twist is heavily weighted towards 10-30 years. But what is the point? As much as I disliked QE2, I think I dislike Operation Twist even more. Weve been in an extremely low rate environment for several years now. High rates aint the problem - in fact, real interest rates are already negative. What we need is demand. This feels like the Fed would rather be doing something than nothing. Ben: I know were supposed to be politically independent, but elections are coming up and frankly I am appointed by the President, so that notion is as silly as Penn State being called an offensive powerhouse. QE3 is a political landmine, but I dont want to be accused of doing nothing. So lets announce a new form of quantitative easing so we can eventually unveil Operation Twist 2.0. And when that becomes a political liability, well unveil another easing measure and start over again at 1.0! Quantitative easing measures should be kept in a glass box that says Break In Case of Emergency. Instead, they have become the standard MO for a Fed stuck with a muddling economy and a terrible job market. What tools will we use when the next bubble bursts or liquidity crisis? Keep an eye on stocks. With the European crisis coming to a head and lingering disappointment over Operation Twist, we could see massive selling on Monday and Tuesday. I will caution you that the only thing I do worse than make rates calls is equity calls, but things just seem to fragile right now. European Credit Crisis Mainstream news finally caught onto the European crisis and we actually saw a couple of WSJ headlines on the subject! Apparently the Journal is now hiring former rating agency analysts as journalists. S&P noted publicly that an expansion of the EFSF will potentially trigger credit rating downgrades in the region. The EFSF is basically two countries, Germany and France.

As their liabilities increase, so does the likelihood they get downgraded. France is hanging on by a thread to begin with, so whats the big deal? Countries in the EFSF have to be rated AAA. That means when France is downgraded (when, not if), Germany will be forced to make up the difference. On Wednesday, the ECB confirmed it had loaned $500mm to an unidentified financial institution. My money is on a French bank struggling to obtain dollar funding. From a Reuters report over the weekend regarding Bank of France head Christian Noyer: Noyer, who is also a member of the European Central Bank's governing council, said that French banks were well capitalised and could withstand whatever scenario plays out concerning Greek debt with profits made in less than a fiscal halfyear. "They are very solid," he told Le Journal du Dimanche (JDD) in an interview published on Sunday. "They have a solid capital base, comparable to other European banks and they are profitable ... None of them is hiding any toxic assets." This tells me three things: 1. Noyer must have attended Giethners Conference on Idiotic Statement, 2. French banks are in deep trouble 3. Noyer & Co. should be unveiling a plan to bail out French banks by the end of the week. The IMF released a statement on Saturday, here are some excerpts: The global economy has entered a dangerous phase, calling for exceptional vigilance, coordination and readiness to take bold action from members and the IMF alike. We are encouraged by the determination of our euro-area colleagues to do what is needed to resolve the euro-area crisis. We welcome that the IMF stands ready to strongly support this effort as part of its global role. Today we agreed to act decisively to tackle the dangers confronting the global economy. These include sovereign debt risks, financial system fragility, weakening economic growth and high unemployment. Our circumstances vary, but our economies and financial systems are closely interlinked. We will therefore act collectively to restore confidence and financial stability, and rekindle global growth. If the IMF is finally showing up to the party, things must be getting bad. And if thats not enough, Germany is starting to make rumblings about requiring certain terms of Greek default before it will serve as a backstop. Germany wants private bond holders of Greek debt to take a loss of 50% instead of the proposed 21%. Germany is set to vote on the validity of the EFSF on September 29th, and the ability of Greece to remain within the

Euro is probably dependent upon it. Fitch, not exactly the standard bearer for timely analysis, refuted this on Friday: Concerns over the risk of a break-up of the euro zone are greatly exaggerated," said David Riley, Fitch's head of global sovereign ratings. According to anonymous G20 sources as reported by Sky News correspondent Ed Conway: G20 is preparing itself for Greek default in November, after the Cannes summit on November 3 and 4th All G20 efforts aimed at recapitalizing banks and preparing economies for default Emergency funding should keep Greece afloat through October

US CEO said the bank is not looking to raise funds, which means that is exactly what they are doing. Anytime I hear a bank executive repeatedly insist the bank is well funded, all I hear is Im long my banks stock, Im long my banks stock, Im long my banks stock. And UBSs CEO got fired in response to the rogue trading scandal that lost the firm $2.3B. This makes me wonder: How many rogue trading scandals that result in profit go unreported? On Tuesday, Reuters reported that the Bank of China had suspended some fx swap lines with several European banks. The WSJ reported that European banks have lost $700B in short term dollar funding mechanisms (such as money market funds) as managers pulled back over concerns about Greece et al. LIBOR Outlook 3 month LIBOR is up 10bps in the last two months. Nothing to write home about, but it reinforces the notion that funding issues linger. Fixed Rate Outlook You have to look at 7 years and beyond to get more than a 1% yield. This creates a mentality of yield grab where investors seek higher returns through riskier investments. Which in turn can create a bubble. The 10 year Treasury yield touched 1.72% and all evidence suggests that moving lower to 1.50% seems completely likely. Shorter term maturities, mainly up to 3 years, will be under some upward pressure. If youve been looking to lock a rate or buy a cap for under 3 years, you may want to consider moving forward.

With a flatter yield curve, borrowers will have incentive to lock in for longer terms. If the spread between 2 year rates and 10 year rates narrows (as expected), it becomes cheaper on a relative basis to lock in long term yields. Whether you are locking in swaps or fixed rate financing based off of Treasurys, please give us a call to ensure you are locking in a rate that captures the drop in rates.

This Week A much slower week ahead after last weeks insanity. Durable Goods on Wednesday is an important release given the manufacturing deterioration lately. GDP on Thursday. But the numerous Fed speeches will be closely monitored for additional insight into the Feds mentality. And as always, keep an eye on Europe. True story that proves beyond a shadow of a doubt that my youngest son definitely belongs to me. He was outside playing in the rain over the weekend and had a sword in one hand, a sheath in the other, and his two shoes off to the side. I asked him to come in and to bring his shoes. He explained that his hands were full and couldnt carry them inside. I told him to put them on his feet and come in. So he sat down and tried to put the sword sheath on his foot. He might be Secretary of Treasury some day.

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Economic Calendar
E conom Data ic Day M onday Time 8:30AM 10:00AM 10:00AM 10:30AM Tuesday 10:00AM 10:00AM Wednesday 8:30AM 8:30AM Thursday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 10:00AM 10:00AM 11:00AM Friday 8:30AM 8:30AM 8:30AM 8:30AM 8:30AM 9:45AM 9:55AM Report Chicago Fed Nat Activity Index New Home Sales New Home Sales MoM Dallas Fed Manufacturing Activity Cons umer Confidence Richmond Fed Manufacturing Index Durable Goods Orders Durables Ex Trans portation GDP QoQ (Annualized) Personal Cons umption GDP Price Index Core PCE QoQ Initial Jobless Claims Continuing Claims Pending Home Sales MoM Pending Home Sales YoY Kans as City Fed Manufacturing Activity Personal Income Personal Spending DCE Deflator (YoY) PCE Core (MoM) PCE Core (YoY) Chicago Purchas ing Manager Univers ity of Michigan Confidence 0.1% 0.2% 2.9% 0.2% 1.7% 55.5 57.8 0.3% 0.8% 2.8% 0.2% 1.6% 56.5 57.8 Forecast -0.40 295k -1.0% -8.0 46.2 -9 -0.4% 0.0% 1.2% 0.4% 2.4% 2.2% 420k 3728k -1.7% 6.3% Prev ious -0.06 298k -0.7% -11.4 44.5 -10 4.0% 0.7% 1.0% 0.4% 2.4% 2.2% 423k 3727k -1.3% 10.1%

E ents and Speeches v Day M onday Time 9:15AM 9:30AM 9:30AM 12:00PM 3:00PM Tuesday 12:30PM 1:20PM Wednesday 2:40AM 5:00PM Thursday 2:50AM 8:30AM 1:00PM Friday 11:00AM Rep ort Fed's Ras kin speaks on Monetary Policy Fed's Bullard s peaks ECB's Bini Smaghi s peaks ECB's Weidmann speaks Fed's Kocherlakota speaks on Debt Panel Fed's Lockhart s peaks on Economy Fed's Fis her s peaks on Diss ent Fed's Rosengren speaks at Swedbank Seminar Fed's Bernanke s peaks Fed's Rosengren speaks at Bank Regulation Fed's Plos s er speaks on Economy Fed's Lockhart s peaks Fed's Bullard s peaks Place Washington, DC New York, NY New York, NY Washington, DC Chicago, IL Jacks onville, FL Dallas , TX Stockholm, Sweden Cleveland, OH Stockholm, Sweden Radnor, PA Atlanta, GA San Diego, CA

Treasury Issuance Day Tuesday Wednesday Thursday Closing 1:00PM 1:00PM 1:00PM 2 year Treas ury 5 year Treas ury 7 year Treas ury Issues Size $35B $35B $29B